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A small company with Jumbo potential

Catherine Baab-Muguira

Many Australian companies have a dubious track record when it comes to overseas expansion, but there’s one small cap stock currently making big gains as it speeds into new markets courtesy of the online business model it’s proven out locally.

This is Jumbo Interactive, based in Brisbane. The quite small company has a market cap just over $80 million and already had good growth prospects ahead. Today alone, shares have jumped 15% with the announcement that the company has been granted licenses to sell lottery tickets via web and mobile throughout Germany (it had previously secured the rights to sell in just one German state).

This is significant, even ‘jumbo’ news, as the company estimates the online lottery ticket market in Germany will be worth $2 billion in five years. Yet for investors, the growth story may just be beginning.

Domestic business

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Today, Jumbo has an established Australian business. It operates the popular gambling site OzLotteries.com, among other lottery and game sites. These involve customers buying lottery tickets, such as those sold by Tatts Group (ASX: TTS), with Jumbo acting as an agent and earning a portion of sales. This online lotto-agent business has high margins and may still grow following the incredible success of the last 10 years, in which net profits grew from a net loss to nearly $7 million for the 2012 financial year.

To keep up with technological trends, the company has also developed smartphone apps and a number of other innovative products that enable customers to buy lottery tickets no matter where they are and to play lotteries with their friends through social media sites such as Facebook.

With the overall Australian lottery market worth $4 billion according to company estimates (and online lottery sales representing less than 10 per cent of total lottery ticket sales), while Jumbo's total transaction value looks to be between $102 million and $106 million for 2013, given the trend towards online purchasing of all manner of goods, this company looks to be a winning ticket in years to come.

International expansion and opportunity

The international opportunities are especially exciting. Jumbo has recently expanded into Latin America, announcing a deal to help introduce and manage online lottery sales in Mexico. It has also moved into Germany, securing the rights to sell lottery tickets via web and mobile in one German state already, with plans in the works to acquire licences in other German states.

Most recently, Jumbo has moved into the US market, signing a joint-venture deal with Retail Gaming Solutions, a privately held American company, to provide in-store rewards systems at about 1000 convenience stores throughout the US. (Trials of the program found that lottery ticket sales rose some 38 per cent after the introduction of the Jumbo/RGS rewards systems, suggesting the system is very much a win-win.)

Jumbo estimates that these new markets contain some 500 million potential customers and are worth more than $70 billion in lottery sales. (Consider that the portion of lottery sales completed online has reached 15 per cent in the UK and 30 per cent in Finland in recent years.) Should the company eventually capture but a small fraction of these customers and sales, it's likely that Jumbo will move quickly out of small cap territory.

Still, such a win is not going to happen overnight. Potential investors need to be patient when it comes to this company.

Balance sheet and valuation

Jumbo Interactive currently has a strong cash position and no debt. This should allow it to keep pursuing its expansion efforts.

Shares appear relatively cheap, trading for 14 times trailing earnings. However, full-year 2013 earnings are likely to be much lower than 2012 earnings on account of the impact from expansion efforts and some accounting changes – another reason this play is one for long-term oriented investors.

The risk of being a third party

A key risk to bear in mind when considering an investment in Jumbo is the company's status as a "third party". That is, the game owner/licence manager could choose not to allow sales through Jumbo sites, but instead keep all the cake for himself, as it were. While some long-term agreements help to contain this risk, it's important to recognise that the balance of power isn't entirely in Jumbo's favour.

Foolish takeaway

Those looking for a pure gamble may want to stick to lottery tickets. But if you're a patient, long-term investor looking for a bit of small-cap spice to add to your diversified portfolio, Jumbo Interactive shares could be a good bet.

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Catherine Baab-Muguira is a Motley Fool writer/analyst. You can follow The Motley Fool on Twitter @TheMotleyFoolAu. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.